Thursday, October 01, 2009

Challenge-d

By Neil H. Buchanan

The current (September-October 2009) issue of Challenge: The Magazine of Economic Affairs includes my article: "Generational Theft"? U.S. Fiscal Policy Does Not Cheat Future Generations. (Unfortunately, at some point during the editing process, the quotation marks around "Generational Theft" and the question mark were deleted. The result not only loses the ironic reference to Sen. McCain's unfortunate turn of phrase but actually makes the title self-contradictory. Such are the fortunes of publishing.) In that article, I make the point that, whatever one thinks the moral obligations are between generations regarding economic prosperity -- a topic that readers of this blog know is of some interest to me -- the existence of a significant economic downturn has at least one fortunate effect: it aligns the interests of current and future generations such that both groups are helped by a deficit-financed, expansionary fiscal policy.

The usual view of deficits as being akin to "theft" by current generations from future generations is based on the assumption that the economy is running at roughly full capacity, meaning that any deficit spending now will divert resources from private investment in future productivity (either by requiring the government to borrow funds that private businesses would have used to expand their businesses, or by borrowing funds from abroad, thus obligating unborn generations to pay interest to foreign investors).

There are many problems with that argument, on which I have written at some length over the course of my career (and I am certainly not alone); but whatever impact that argument should have on fiscal policy during times of prosperity is negated when the economy is in a hole -- and the deeper the hole, the less true is the conventional story. Since the concern is that the economy's resources will be diverted from productive private uses to public use, the most important fact about a recession (especially one as deep as the current recession) is that private industry is currently leaving plenty of resources unused -- for very understandable reasons, given the lack of demand for private businesses' current outputs. Because of this, the government's hiring of resources to rebuild roads, etc. does not prevent private industry from using those resources to invest in the prosperity of future generations.

In fact, the federal government's intervention in the economy helps future generations, in two distinct ways. First, federal stimulus spending starts to create an atmosphere in which private businesses find it sensible to invest in their future productive capacity, whereas such private investment would be forsaken for completely rational reasons if the economy had continued to stagnate or shrink. Notably, this is true even if the federal money is not spent on investment items but instead is purely used to put people back to work on projects with only immediate benefits. Second, if the federal spending is spent on projects that themselves contribute to growth in productivity, future generations will benefit further by inheriting a more productive economy than they otherwise would have inherited (and in the U.S., at least, they will already be receiving a pretty spectacular economic bequest -- although this is counter-balanced by the environmental damage about which we seem much less concerned).

Many readers will recognize this as old-fashioned Keynesianism, which is exactly what it is. Even so, these ideas have generally not been taught in economics courses over the past few decades, as Keynesian ideas became unfashionable. It is interesting, therefore, that in the same issue of Challenge (and, I am told, in other articles and a book), Judge Richard Posner announces that he is now a Keynesian. Actually, as Bob Hockett explained on this blog earlier this week, Posner is now what would generally be known as a Post-Keynesian, because the label Keynesian has over the years been split into different schools of thought. The basic idea, however, is that the existence of uncertainty (as opposed to risk, which is quite different from true uncertainty, as explained by my colleague Sarah Lawsky in a recent article) undermines many of the models that purport to show the self-correcting nature of a capitalist economy.

As a lifelong Post-Keynesian, I welcome all converts. Posner's conversion was a surprise, but it shows that extreme times can have unexpected and positive side effects.

5 comments:

Although the apparent adoption of a by line at the top of posts is no doubt sensible, and I do not advocate its repeal here, I have to note selfishly that it is depriving me (and probably others) of the game where I challenge myself to identify the author as quickly as possible. Such are the fortunes of online publishing! ;)

Keynes espoused the view that federal bureaucrats could "adjust" the size and scope of government activity and spending like an accordion to ameliorate harm done by cyclical economic downturns. Even if this were possible in theory it never works in practice. Bureaucrats are self-interested. It is foolish to think they ever would be the author of their own demise when it is time for the government to shrink. Rent seeking, which increases in direct proportion to the size of the government, misallocates resources and slows economic productivity. Government never acts like an accordion; its universal tendency is to act like a ratchet, to grow and never shrink. In the long run its growth always reduces economic freedom which is the only thing that increases productivity. It is not surprising that JMK quipped "we are all dead in the long run." He understood his economic theory, even if it worked in the short run, would be disastrous in the long run. His was a morally bankrupt philosophy. Take two doses of "The Constitution of Liberty" by F.A. Hayek, along with a few readings of "Capitalism and Freedom" by Milton Friedman, implement the ideas they advocated, and things will look a lot better both in the short term and in the long. There will be no inter-generational theft.